Journey beyond the London bunker for pockets of value

London has become such a well-rehearsed story for property investors in the UK that it is beginning to sound a little old, at least for those looking for the next chapter in the evolving market recovery.

There are forgotten office, retail and industrial markets outside the M25 where prices have barely moved since the end of the property crash. For many these will be untouchable given worsening economic conditions, but for others they represent a considerable opportunity to chase higher yields and add value at bargain prices.

One of the most positive trading statements so far this busy quarter has been that of St Modwen, whose confident outlook stubbornly refused to be cowed by its exposure to secondary property, regional locations and unplanned development land.

The strength of its statement highlights the bunker-like mentality those in London can have about investment outside the capital, where the search for safe assets has led to prices reaching pre-boom levels. There is, of course, little sign of the London market faltering, given new sources of overseas cash from private families or sovereign wealth looking to acquire prime assets simply as a means of parking cash for the future. The tumult in Egypt is only likely to encourage further investment from the Middle East in safe London property assets.

But neither is there likely to be strong growth in the market any longer. While prime rents have yet to reach pre-crisis levels, the expectation for growth has already been priced into many deals.

Investors will need to look elsewhere to drive returns. For some that means other European markets, but there are still pockets of value in the UK regional markets that remain oversold.

There were £5.4bn of sales in London in the last quarter of 2010, according to CoStar, which at almost two-thirds of the total in the UK highlights the neglect of the regional markets. Average London yields stand at 5.75 per cent, down 115 basis points in 2010, while regional yields are about 7.6 per cent on average, with no change over the past year.

The markets with yields closest to peak are the West End and the City, while those furthest from peak include Birmingham, Leeds and the Thames Valley and M25 markets.

This gap between prime and secondary property yields is near its highest on record. If investors want to move from wealth preservation to wealth creation in anticipation of a wider recovery, then this is a gap that needs to be exploited. Unsurprisingly the most opportunistic companies have already been buying aggressively in high-yielding property, according to CoStar, with Max Property, led by entrepreneur Nick Leslau, at the top with an average purchase yield of almost 13 per cent in 2010, followed by other nimble traders such as Helical Bar and Development Securities.

“Pick a subdued market where there is still a heartbeat,” advises Ezra Nahome, chief executive of Lambert Smith Hampton, the property agents. “Look where there are few new buildings, where there is demand to come but where bank debt will keep development low.”

Caution is still necessary of course. The climate for property investment is still poor in many areas given what might happen once the government cuts start feeding through to reduced consumer confidence, unemployment numbers and curtailed business investment.

Even so, there are plenty of strong companies occupying modern office or retail space on long leases in regional towns and cities, and the price often offsets the risk.

According to Drivers Jonas Deloitte, all regional cities apart from Manchester recorded falling rents during 2010, but it sees no further rental declines this year.

All five key regional cities recorded increased take-up levels in 2010 and there is no speculative construction. Oversupply of space needs to be absorbed, of course, but 2011 should at least see the corner turned for rent growth. Alex Price, chief executive of Palmer Capital, has a specific mandate to acquire regional offices. Manchester and Birmingham are hardly small towns, he points out, and these are also the sorts of places where the banks are most likely to be pushing sales.

There are similar themes being played out in the listed market. Harm Meijer, analyst at JPMorgan, says that prime will outperform secondary property “but this is already largely priced in on the equity market”. He recommends some “bottom fishing” in the smaller stocks such as Development Securities, Capital & Regional and St Modwen.

One large Asian private family investor said last week that the big advantages of buying prime London buildings was they did not require much effort to maintain from Hong Kong. There is no such excuse for companies based in the UK, even if travelling the Central line is easier than braving National Rail.

dan.thomas@ft.com